Buying and selling a company – Management Buy Out

Introduction

We were asked to advise on a tax efficient way for the Founders to hand over control to an existing employee and minority shareholder. The Founders wanted to have a minority stake in the business going forward.

The Issue

The minority shareholder did not have the funds to purchase the shares outright from the Founders. As an existing employee, we also had to consider the Employment Related Securities legislation.

How we solved it

A Newco was formed which acquired all the shares in the trading company (“Oldco”). The minority shareholder exchanged shares in Oldco and the Founders exchanged their shares for a combination of cash, loan notes and shares in Newco.

The outcome

The cash consideration and redemption of loan notes was funded from the future profits generated by the trading company enabling the employee to end up with a majority shareholding for a relatively small financial commitment.

Next Steps

Do you want to hand over control of your company? Do you want to ensure this is done in the most tax efficient way? Contact us and our team of expert tax advisers will be happy to guide you.

VAT on starter business investments 

Introduction 

Our client ran a firm that specialised in finding investors for high-tech startups. They had a complex commission structure partly based on the potential future value of the businesses into which investment was placed. 

The issue 

Our client had received conflicting advice on the VAT treatment of its activities.  

How we solved it 

We reviewed the activities, its sources of income including the mechanism under which it was paid for its services. We reached a conclusion, based on sound analysis of the VAT legislation, HMRC guidance notes and relevant caselaw, that our client’s services were VAT exempt.  

The outcome 

Our client was able to move forward with certainty on how VAT applied to its business. 

Next Steps

If you are having difficulty navigating VAT for your business then get in touch with ETC Tax and we can guide you on all tax matters.

CASE REVIEW: SDLT – Non Residential / Residential

Introduction

Stamp Duty Land Tax (SDLT) is a tax imposed on property purchases in the UK, with rates varying based on whether the property is classified as residential or non-residential. Classification ambiguities can easily lead to disputes.  Two recent cases highlight these complexities and their respective resolutions.

Overview

In August 2021, Ms. Anne-Marie Hurst purchased a 16th-century manor house in Devon for £1,800,000 and filed her SDLT return under non-residential rates. She argued that the property was used as a ‘hotel or inn or similar establishment’ and noted that a meadow within the grounds was leased commercially for grazing and hay harvesting. HMRC disagreed, issuing a closure notice reclassifying the property as wholly residential, leading to an increase in SDLT of  £47,750.

Hotel???

Ms. Hurst, who had previously operated a wedding venue and a wine business, intended to use the manor in a similar capacity. The vendors had upgraded the property to function as a bed-and-breakfast or boutique hotel, offering high-quality accommodation despite COVID-19 restrictions. Ms. Hurst chose not to purchase the business as a going concern but focused on the property’s fixtures and fittings. After the purchase, she converted parts of the house for self-catering accommodations and formalised a commercial lease for the meadow at £500 annually. Upon review by the courts, the taxpayers appeal was allowed on the grounds that the property had been used as a hotel, saving Ms Hurst the additional liability plus interest which HMRC had intended to levy. 

Case of Mr. Taher Suterwalla and Mrs. Zahra Suterwalla v HMRC [2024] UT 00188

In the case of Mr. Taher Suterwalla and Mrs. Zahra Suterwalla v HMRC [2024] UT 00188, the Upper Tribunal (UT) upheld the First Tier Tribunal’s (FTT) decision that a paddock was not part of the residential property grounds. The Suterwallas had purchased a house with a tennis court, indoor swimming pool, pavilion, and paddock, letting the paddock out for horse grazing on the day of completion. They filed their SDLT return as non-residential, but HMRC issued a closure notice, reclassifying the paddock as residential and applying the residential SDLT rate.

The FTT ruled in favour of the taxpayers, and the UT upheld this decision, finding the grazing lease irrelevant since it did not exist at the time of purchase and there was no evidence of prior commercial use. The paddock had a distinct title, was not visible from or integral to the house, and did not support the dwelling or other amenities. This decision emphasizes that post-completion use, such as a grazing lease, can still influence the property’s classification at the time of purchase, depending on specific case details.

The complexities of SDLT classifications

Both cases underscore the complexities of SDLT classifications and the significant tax implications tied to property use definitions. They highlight the importance of accurately assessing and documenting property use at the time of purchase, as post-completion arrangements can affect tax outcomes. These rulings provide valuable precedents for understanding how properties with mixed uses may be classified for SDLT purposes.

If you require our support regarding stamp duty land tax please contact us.

We have been supporting our Tax Partner Pro members via our email and call back service. Here’s an overview of some of the more recent questions we have answered during July 24

Q

My client has the following income  – UK State pension / uk self employment / uk rental income

This will all continue – however he plans to live for 7 months a year at his Portugal home (he has a permanent residence permit) and then return to the UK for the remaining 5 months of the year.

He will have no income generated in Portugal.

Broadly once this happens does he continue to complete his UK tax return as normal and pay UK tax?

Then have an obligation to declare all this income in Portugal and pay no further tax due to double tax treaty.

A

Its difficult to determine whether he’d become non-uk resident from the information provided as it’s largely based on number of days in the UK / ties to the UK etc.

If someone is spending 5 months of the year in the UK, more often than not they will remain UK resident.

As a result, the answer is yes, he would continue to declare his income in the UK and pay tax here.

The double tax treaty between the UK and Portugal will dictate which country holds the primary taxing rights and which therefore must give relief. I’d imagine if the sources of income are UK based, the UK will retain those taxing rights and Portugal will deduct UK tax suffered from their calculations.

Q

A client of mine is working with a US company who will only work with her as a sole trader.

She maybe wants to set up a limited company (she will be the sole director) to work with other clients and she is asking me if she can invoice the sole trader to get the funds in to the limited company.

Are you able to confirm?

A

I would expect that there will be withholding tax in the US in which case it will have to stay as sole trader income, otherwise there won’t be any relief for the tax withheld.

You are correct that there isn’t really anything commercial to invoice – the service has already been provided by the client personally.

If there isn’t any withholding tax, you could say that the client was acting “as agent” for the limited company then it could be regarded as the company’s income.

Q

I have a query about registering for vat in the EU.

A client provides medical writing services, clients send her instructions on what they need written up, e.g. a scientific manuscript or an abstract for presenting at a science conference. She has clients in France and Ireland, currently at low levels of turnover (£5k and £2k) but may increase significantly. Does she have any EU VAT responsibilities?

A

If it’s B2B, the place of supply will be deemed to be where the customer belongs. If this is the EU then the customer will account for the relevant VAT under the reverse charge mechanism. When goods or services are supplied in other EU countries, the Reverse charge moves the responsibility for recording the VAT on the transaction from the seller to the buyer.

That way, it eliminates or reduces the obligation for sellers to VAT register in the country where the supply is made.

Q

I have a client who has a holding company. They haven’t been registered with HMRC for corporation tax so far as there has been no trading. But at some point they started paying dividends to the holding company from a subsidiary. Is this classified as investment income and should they have contacted HMRC to say they are active for corporation tax purposes now or can they still be exempt from filing corporation tax returns? There is no other transactions in the holding company.

They have also paid the dividends directly to the shareholder of the holding company from the subsidiary (the holding company has no bank account). I guess this is ok as long as they have all the evidence of the dividends going via petty cash?

A

If all the holding company is doing is passing through dividends to the shareholders then I can’t see that would affect the overall position as regards treating it as dormant from HMRC’s point of view.  If the company starts to build up a cash balance and earns interest then of course that changes the dynamic…

In terms of paying direct then I’d say as long as the right book entries go through then again this is not an issue.  I’d suggest though making sure the right dividend paperwork is also in place – resolutions etc – again just to evidence the payment of the dividend first from sub to Holdco and then from Holdco to the shareholders…

Next Steps

Don’t forget to get in touch as part of your Tax Partner Pro membership. [email protected]

Case of the month – Complex Self-Assessment Tax Return

Introduction

Our client approached ETC Tax with fairly complex tax affairs after being made redundant throughout the year and making a significant sale of shares in his ex-employer.

Issue

Our client had various factors to consider, such as:
• Various gift aid payments;
• A previous assignment overseas;
• Redundancy payments received from his ex-employer, outside of payroll;
• Payment discrepancies from his current employer;
• Exercising share options and the eventual sale of overseas shares, with foreign tax paid;
• The sale of shares part of a Share Incentive Plan;
• Income and expenses associated with his UK rental property
• Various excessive pension contributions
• EIS investments

How we solved it

His affairs required significant research and attention to detail. We worked to ensure every aspect was covered and he was maximising the reliefs available to him, which a lay person may not be aware of.

Penalties for inaccurate reporting can be hefty, therefore it was important to the client that the tax return was correct and on time.

The outcome

We were able to successfully prepare the tax return for the client, which included a detailed supplementary letter confirming what was reported, any reliefs available and the ultimate effect on his liability.

This provided the client with certainty and the confidence that they had maximised their potential savings.

Next Steps

If this sound familiar with one of your clients and you want to find out more get in touch

So, what is a demerger anyway?

Demerger is a bit of a catch-all term for any situation where a company or group of companies splits itself into two or more parts. 

This can be for any number of reasons…

It may be that part is to be sold and part retained

Shareholders may have agreed to go their separate ways

There is simply a need to keep certain groups of assets entirely separate from each other. 

Whatever the reasons, there are a number of different options available, some of which are more straightforward than others.  All can be affected either totally or largely tax-free, but equally all come surrounded by a raft of conditions which must be met in order to avoid any unexpected liabilities.

Case study

Janet and John are the shareholders in a holding company (J&J Holdings) which has two trading subsidiaries – Ladybird Ltd and Penguin Ltd.  The group has been in place for many years and both companies are trading successfully.  However, because some customers have become concerned about the group ownership of both companies, Janet and John have decided that commercially it makes more sense for them to have more direct ownership of Ladybird Ltd and want to remove it from under the holding company.

Direct statutory demerger

This is the simplest demerger situation – known as a “direct statutory demerger.”  Provided the conditions are met then J&J Holdings can simply “distribute” the shares in Ladybird Ltd to Janet and John tax- free so they now own directly the shares in J&J Holdings which owns Penguin Ltd, and at the same time they own the shares in Ladybird Ltd directly.  Specific rules mean there are no capital gains or income tax issues arising for Janet & John.

The key criteria here are (1) that the demerger can’t be in anticipation of a sale, (2) the demerger must be for the benefit of one or more of the trades (3) the company being distributed must be a trading company and (4) the company making the distribution must either be a trading company or the holding company of a trading group.

Because the distribution is direct to Janet and John this will be a disposal of the shares in Ladybird Ltd for corporation tax purposes.  Normally this would be at market value but as the group has been in place for a while the substantial shareholdings exemption should make the gain tax free…

Stamp duty can be an issue in demergers (see below) but in this instance the shares are transferred by way of a “distribution in specie” with no consideration given so stamp duty should not be an issue.

From a company law point of view the amount of the distribution can be set at the book value of the shares in Ladybird Ltd so provided J&J Holdings has the distributable reserves to cover that book value then there should be no issues from an accounting or company law point of view.

Indirect statutory demerger

Let’s make a slight tweak to the situation.  The Penguin and Ladybird trades are instead operated within the same company which is directly owned by Janet and John.  Surely the simple option here would be to transfer the Ladybird trade into a new subsidiary of the current company and then undertake a direct demerger as discussed above?

On the face of it yes, but the existing company is still disposing of its shares in the new Ladybird Ltd and this will be a market value sale for corporation tax purposes.  Because no group has previously existed and the new Ladybird company will not have been owned for more than 12 months the substantial shareholdings exemption will not apply and so the market value gain will be taxable in the existing company.

This is where an indirect demerger comes into play.  Instead of distributing the new Ladybird Ltd to Janet and John directly, they form a new holding company which they won in the same proportions as the existing company – let’s call it J&J Holdings 2024 Ltd.  The existing company then distributes the shares in Ladybird Ltd, but not to Janet in John.  Instead they arrange for the distribution to be made to J&J Holdings 2024 Ltd in exchange for that company issuing them with new shares.

This may seem an odd way to do things but it allows us to access the tax free company reorganisation provisions which mean we don’t have to rely on the substantial shareholdings exemption to make the disposal of Ladybird Ltd tax free. 

The rest of the analysis is fairly similar, save that there has been consideration given for the distribution of Ladybird Ltd (the new shares issued) so we need to rely on the stamp duty reorganisation provisions in order to make sure no stamp duty arises on the transaction.

Statutory partitions

If Janet and John have decided to go their separate ways and one wants Penguin while the other wants Ladybird, either of the options above can still work for them – this is what is known as a partition demerger.  Little changes in this situation save that in the case of an indirect statutory demerger there is likely to be a stamp duty charge because there is not an exact mirror in the shareholdings before and after the transaction.

Non-statutory demergers

As may be gleaned from the above, there will be many occasions where a statutory demerger is not suitable.  This can be because one of the businesses being split is not trading, or perhaps because the transaction is being undertaken in anticipation of a sale of one of the companies.  In both situations the conditions for the tax-free demerger will not be met and so significant tax liabilities may arise. 

In the past the only practical route available was a liquidation demerger as discussed briefly below.  However, changes in company law around capital reductions means that a capital reduction demerger is now a viable alternative in many situations.

Liquidation demerger

A liquidation demerger pretty much does what it says on the tin.  The company (or more often a new holding company) was placed into liquidation and the liquidator distributed the subsidiaries to new holding companies owned by the shareholders.  In exchange, the new holding companies will issue new shares to the shareholders. 

As mentioned above at one stage this was really the only viable alternative where a tax exempt statutory demerger was not available.  However it is not without its complications.  There can be SDLT issues, there is the cost of the liquidators to factor in and at an emotional level some business owners still associate the term liquidation with insolvency (however much that is not actually the case).

There may still be a preference for a liquidation demerger but they are increasingly rare.  The world of tax may not be one well known for being a dedicated follower of fashion but a new kid on the block has in recent years grabbed all of the attention – the capital reduction demerger.

Capital reductions demergers

In the dim and distant past the procedure by which a company could reduce its capital was and long and onerous one and was not one to be approached lightly.  More recently reforms to Company Law have meant that the process for private companies at least is significantly more straightforward. 

The process is rather involved and the precise steps will depend on what the objective of the restructure is.  However at its most basic level the transaction involves the holding company of a group entering into a reduction of its share capital, but instead of paying out cash to the shareholders it transfers the assets to be demerged to a new company owned by some or all of the shareholders.  One of the key requirements from an accounting point of views is that the holding company needs to have enough share capital to cover the market (not book) value of the distribution – if that capital does not currently exist it can be created but the restructure can’t happen without it.

From a tax point of view a number of provisions interact to allow the restructure to proceed without any capital gains tax, income tax or corporation tax consequences.  To be effective each has a number of conditions to be met to be effective but with careful planning this is all achievable.  The over-riding requirement from a tax point of view is that there has to be a good commercial reason for the transaction and we would always recommend applying to HMRC to confirm this in advance.

There can be stamp duty complications again where shareholders are going their separate ways and/or properties are being split so it may not be entirely a cost-free process but relative to the tax costs of not using the approach to achieve a split then these make the structure very economical.  If structured properly HMRC tend to be comfortable with the approach even in anticipation of a sale in the short term.

Are capital reduction demergers complex? 

Yes, relatively they are but with careful planning and the right tax, legal and accounting advice they are perfectly achievable and generally represent the most effective approach to breaking up a group where the restrictive conditions for statutory demergers are not met. 

Next Steps

One tip for the top though – the process can take at least three months from start to finish so early planning is essential to avoid disappointment! Now you know this get in touch with us today!

Introduction

In preparing a tax return for our client, we identified that in prior years he had not been considering his pension contributions and how this could impact his tax liability.

The issue

The issue was that our client may have been liable to pay the pensions annual allowance tax charge due to his excessive levels of contributions.

The contributions were excessive as his income levels were above the thresholds which tapered his annual allowance each tax year.

It is an area that is not particularly well-known to the layperson, so it can be easy to be caught out with unexpected liabilities and penalties from HMRC.

How we solved it

We conducted a review of his income and pension input position in order to establish whether he was liable to pay the tax charge. This included looking back from 2017/18 to 2022/23 at the available allowances, any carried forward amounts and whether his income met the high thresholds.
Once we understood this, we assisted the client in reporting the charge on his self-assessment tax return accordingly.

The outcome

It was calculated that he was due to pay a small pensions tax charge for 2022/23, however for previous years he had sufficient carried forward allowance to cover his excessive contributions.

It gave the client certainty that he remained compliant with HMRC, and due to our advice ensured he was able to plan for his contributions going forwards.

Next steps

Do you need to be thinking about your pension contributions and how this could impact your tax liability? Get in touch for expert advice from our team of highly skilled tax advisers.